Lindsay's Lobes

Wednesday, March 14

Recently a local community radio station North West FM featured recordings by my late father and youngest daughter. They played 'Mosquito' from the RAAF Glee Singers playlist below and 'Something's Better Than Nothing' from Rachael's Sound Cloud as per below.

Tuesday, March 13

An introduction to selection criteria’s to identify potential quality
companies and sensible sector exposure limits within a portfolio

Introduction

This paper was written to assist those not qualifying for government pension to make sage investment decisions. It aims to shed light on the methodologies involved in
identifying prospective quality companies for further in depth evaluation. In
other words I will talk about a selection criteria, which must inevitably involve
some form of filtering.

Adopting a conservative approach with less need for sophisticated
filters

One can opt to take the more conservative option by investing via LICs (Listed investment Companies ),
where the evaluation of quality companies and determining value is a much more
straightforward matter. This was illustrated in my prior paper on the subject.
The advantage of investing in a large cap LIC is it will mostly cover the
entire index for you.

However, to enhance your overall returns, you could also include in your
portfolio a small cap LIC, on the expectation you expect small caps to
outperform large caps. Another option is to include a LIC whose investments are
principally overseas, should you consider the prospects are superior abroad.

It’s a matter of feeling comfortable with an investment strategy that reflects
you aims and risk appetite.

Sector exposure is also important to the extent we don’t want to

be overweight
and risk a larger fall than applies to the index.

Sector weightings

To recap it’s risky to be materially overweight in
any one sector relative to the ASX. Their website provide relevant free information
on sector weightings and performance. But it can be devilishly difficult to
find. This paper sets out the detailed search steps for you.

However, before that, I need to quickly dispel the questionable
common theme diversification in itself provides quality
and safety.

The questionable theme
of quality through diversification.

This is the idea that a diverse mixture across different asset classes
affords safety since as one sector falls it will be compensated by a rise in
another asset class held in a portfolio. This is only true at times and it’s a
terrible idea if you were only to be invested in shares and interest bearing
securities. By way of example take the present US market where most interest rates
are fixed whereas in Australia they are mostly variable. The risk for a US
investor is if both inflation and interest move up faster than is anticipated,
both Bonds and shares will both fall. That’s not the case for Australia because
variable rates apply here (as in so many points over the 90 bank bill rate) so shares
could fall but it doesn’t mean a fall in interest bearing securities. But nor
does it mean one asset class affords protection over the other.

And if there was to be much higher interest rates in Australia I think it
very likely house prices, consumer discretionary shares and banks would all
fall simultaneously. The so called safe haven gold sector long term is one of
the worst long term performers whose price does not keep pace with inflation.
That doesn’t mean all the shares in the sector are duds, as you have some that performed very well.

Sensible sector limits

Rather obviously there is nothing wrong with diversification, except don’t
presume it will always protect you, to offset falls in one asset class with
rises in another. Instead what I propose for you is to consider a few simple
rules:

1.No share or individual security to exceed 5- 10% of your
total investment portfolio. I use 6%.

2.No sector exposure exceeds 15 to 20 % of your total
portfolio. I usually use 15%.

Limiting exposure to sectors

However, one can calculate accurately each sectors
current relationship with the total index at any time. I invite you now to
follow these links from the ASX website

·Starting from home click on the top heading called Products
and ·Scroll down to the heading Indices – click on
that.

This will take you to the screen headed ‘What are
indices.’

·Scroll down under that until you see the sub heading of
‘Types to sector indices.’ ·Click on sector indices

·Scroll down the heading and narrative headed ‘Types of
indices’, until you see the minor heading: to learn more, please refer to the overview of
Sector indices.

·Click on that and it will take you to the indices. You are now in the position to utilise the wealth of information available in relation
to the above indexes. Scroll down to the Index with explanatory narrations. By
way of explanation click on S&P/ASX 200
Consumer Discretionary Index. This index provides investors with a
sector benchmark that reflects all entities in that index. The index provides
facilities to measure (1) its relative performance to the broader S&P/ASX
200 and (2) Its relative size or % to the S&P/ASX 200. Additionally there
are related comparable indexes to compare such as the S&P/ASX small
ordinaries, franking credit adjusted total return index.

Hence you
can carry out an exercise for each of the sectors as above to gauge the current
respective sector exposures and returns. That can then be compared with your holdings
under those sector classifications. You
are then is a position to determine what percentage your holdings compare to
your portfolio and how that compares with the sectors percentage to the total
index.

An
introduction to filters

As you may recall Professor Benjamin Graham is known as
the father of Value investing, who introduced the ideas of more value
orientated share selection criteria’s.He authored 2 books namely Security Analysis and its
much friendlier publication, Intelligent Investor.

Graham’s selection criteria was as follows:

·An
earnings-to-price yield twice the AAA bond yield.

·A PE ratio
(price-earnings ratio) less than 40% of the highest price-earnings ratio for
the share over the past five years.

·A dividend yield
of at least two-thirds the AAA bond yield.

·Share price no
more than two-thirds of tangible book value per share.

·Total debt less
than book value.

·Current ratio
greater than two.(Ratio of current assets to current liabilities

·Total debt less
than twice ‘net current asset value’.

·Earnings growth
of prior 10 years at least at a 7% annual compound rate.

·Stability of
growth of earnings in that no more than two declines of 5% or more in year-end
earnings in the prior 10 years are permissible.

Comment &
Explanation

Both Graham and
Buffet were very successful in the early days using these filters to unearth
and invest in undervalued entities. Successive acquisitions of undervalued
companies, bore fruit in the form of an expanded share price as the quality of
consistent earnings per share became much more widely appreciated. There is nothing
wrong with applying that criteria to day except I would suggest there are no
companies trading on the ASX who will meet such strict filters. Probably none
in the US either. If there was they would be an aberration and likely to be
subject to some obscure circumstances that would render the share as ones to be
avoided in any case.

To reiterate Graham
and Buffet were hugely successful because they were able to operate in an era when
quality companies could be bought very cheaply as value investing was virtually
unknown.

However, with
the use of computers and enhanced investor knowledge such opportunities no
longer exist. Buffet has repeatedly told investors as far as Berkshire is
concerned the salad days are over. Even so the share price continues to grow
along with his reputations as a sage investor and that of co-owner Charlie Munger.
These days Buffett/Munger talk about 4 key Filters.

The idea of adopting
filters has considerable merit and we can apply more realistic filters today in
many different ways.

Application of
Filters

The easiest way
to apply filters is to evaluate shares within sectors or industries to identify
new potential buys and sells. The advantage of this approach is it is simple
and rather obviously doesn’t involve any additional cost. But it would involve a
lot of manual handling (unless you could plug into a google finance or yahoo
website that has the info) and even more potentially burdensome calculation.

Alternatively there
are many excellent platforms that I have road tested. I prefer Skaffold,
because one determines your own filters. Their system gives me maximum
flexibility. I never take any notice of model portfolios, although I concede
this can be an ideal measure. It’s more a matter I just like to do my own thing
so that if I make a mistake I can only blame myself.

I road tested Stock Dr for 3 months and
I understand the rudiments of Intelligent investor. All are excellent platforms that have their own inherent strengths and weaknesses.
That’s true of course for any system you use and emphasises the importance of
understanding their modus operando, as in their particular way or method of doing something.

Here are 2 illustrative
examples of 2 filters – One for the entire share universe

uOnly quality companies (rated by a number of factors
inclusive of performance metrics ) with a prior track record

uGrown in share value > 5% past 5 years

uFuture consensus growth>5%

uReturn on equity >15%

uHas a continuing funding surplus

uNet Debt to equity < 50%

uSafety Margin over intrinsic value

Others filters might
be confined to sectors, then broken down to micro, small. Medium, and large
caps entities. As you can gather you can build up to a very large number of
filters that can be employed across the ASX and abroad. This filter for
instance is far less onerous aimed at unearthing a dozen or so names for
further in depth analysis.

uFair quality companies (rated by a number of factors
inclusive of performance metrics which aren’t too restrictive) with a reasonable
prior track record.

uGrown in share value > 5% past 5 years

uFuture consensus growth> 7%

uReturn on equity >10%

ufunding deficit no more than 10%

uNet Debt to equity < 100%

uDon’t have a Safety Margin and allow the stock to be
up to 17% over valued.

Wednesday, March 7

This paper was written to
assist in the management of risk for those not qualifying for a government pension
who manage their own investments as self-funded retirees. Because of the appalling low interest rates
one must invest in a variety of equities and interest bearing securities to
secure even a very modest self-funded pension.

This paper is an introduction to
options which facilitate hedging strategies that protect investors from sharp falls.
It can be regarded as purely educational and general in nature. Readers should not
rely on the contents which may not suit individual investors. When contemplating
hedging or using options interested parties should always consult a licenced professional.
The paper will support one tutorial at the University of the 3rd Age devoted to the management of risk.

Introduction

Options are used for a wide group
of securities classified under the heading of derivatives. A derivative is anything
that derives its value from something else, in this instance for options, from
the underlying shares or share indexes. They are only risky when used improperly
for purely speculative purposes or in naked trading. In the 2008 Global
Financial Crisis mortgage backed securities and credit default swaps caused most
of the problems. Options were largely blameless.

Used properly, options can be useful
tools to facilitate modest hedging and gain a small additional income. You can hedge
against individual shares or your entire portfolio by buying an index put.

Similarly rises can also be covered
without the need to buy any more shares by buying an indexed call. Professional
fund managers routinely use indexed options, aimed at enhancing overall returns.The options market can also influence the share
market.

At the end of the paper is a glossary
of terms as a reference point although my aim is to explain comprehensively along
the way.

Options Market

Buyers and sellers take market positions in
the underlying shares according to their assessment of likely trends. Contracts
are for 100 shares. In Australia daily turnover fluctuates from around
500,000 up to a million. Additionally there is about 40,000 daily trades in
indexed options which are traded at much higher values. Contract size is 1000
points plus an investor multiplier of 10, meaning it’s effectively $10 a
point.Option trading can exasperate trends in share
prices and their indexes.

This happens when share prices are very close
to the exercise prices at close proximity to maturity. Traders then will engage
in buying and selling the underlying shares to improve their option outcomes. These
activities can sometimes move prices by 1% or more. You can also gauge market
sentiment by examining the put-call ratio. This is an indicator ratio that
provides feedback about the trading volume of put (sell) options to call (purchase) options. The put-call ratio has long been viewed
as an indicator of investor sentiment in the markets. At the moment it
is bullish.

Options
Terminology -Options Contract

An agreement between buyers and sellers
defining such terms as the underlying security
and the exercise (strike) prices. There
are 2 contract types, namely European, whose underlying shares or index can
only be exercised on maturity and those called American where exercisment can
occur at any time up until maturity.

The above Call option gives the holder the
right to buy, but not the obligation, the designated number of shares at the exercise
(strike) price of
$79.01 which will mature shortly. The exercise (strike) price is
the price a share must go to or move above it before a position can be
exercised for a profit. However, in all cases, because of the unexpired tine
value it makes more senses to sell the share before maturity. Typically this
current option would have been bought many months before when the share price
was closer to $79.01 than when a buyer expecting its price to increase. The
option is very likely to expire worthless but presently would have just a
modest unexpired time value. .

·In or out of money

A call options is in-the-money if
the share price is on or above the exercise (strike) price. A put option is
in-the-money if the share price is at or below the strike price. The option can
be sold at any time prior to expiration. In both cases options can always be
sold prior to expiration when they will have a small unexpired time value.

·Putt Option a Put option confers
a right, but not the obligation, to have bought, at expiration, at the exercise
price, the shares which are the subject of the put option. That is, where shares
are at or below the exercise (strike) price.

This
option also began trading on the ASX options market on the the 26th April 2017
but as a put option. A buyer, say in late January may have bought this Put
option as insurance against a fall in the CBA share price. Rather than expire
worthless, as is the case with the buyer of the call, the put option holder has
partially hedged falls in the CBA share price after allowance for the initial
premium paid.

For this option we can calculate the
intrinsic value and the unexpired time value for a total of the option price as
follows:

Intrinsic value: Exercise Price of $79.01
less current share price of $76.39 =$2.62.

One then adds the intrinsic value for time value
unexpired, which is18 cents. The option is currently trading at
$2.80, so the time value differences continue to decay but will apply up until
expiration.

Hence the time value is ex intrinsic value, a
determinant of two variables (1) time remaining until expiration and (2) the
closeness of the option exercise (strike) price to being in the money.
In summary options are in the money or out when they are at or compare
favourably or not with their exercise (strike) price.

When specifying a particular option it is
customary to refer to the strike price in lieu of the exercise price.

Selling covered calls.

The difference between a seller of calls and
a covered seller is the latter holds already holds the shares in the options
being sold. The seller also receives the premium paid by the buyer. To the
extent the covered call seller receives premiums this could be regarded as a
mild form of hedging against possible falls in the share price. The alternative
is called naked trading and is not recommended.

Hence a covered call is an options strategy
to holds shares (what is called in the industry long positions) but sell options
over those shares aimed at generating increased income. It can call also be
known as a "buy-write".

In summary the position for covered call
sellers is as follows:

Out of money options are likely to see their
option expire worthless.

In the money options can be bought back before expiry by
sellers. For sellers there is always the possibility of selling another contact
at a different exercise price, to recoup or even exceed the buyback cost.

In and out of money is a common industry term to describepositions.
In this case we are talking about an option where the exercise price has been
reached or breached. In other words where the underlying shares or indexes exceeds
exercise prices.

When using European style options one is
protected from being exercised just prior to dividends becoming due, as the
style can only be excised on maturity on the exercisment date.

Indexed options

The exact same principles and contracts apply
except except we substitute share indexes in lieu of individual share prices.
The exercise price then becomes various index levels. A buyers of an index put can
cover an entire portfolio as c insurance against a catastrophic market
crash.

However to ensure premiums are not
prohibitive discounts can be deducted from the current index levels.

Note that by choosing an index exercise price
of 5350 the buyer is prepared to wear as an excess a discount of 10% (545
points) since the index is presently trading at 5895, at the time of writing.

The next step is to calculate how many
contracts we have to enter into. This is calculated by dividing the cover
required of $400,000 by the current index 5895 and applying the investment multiplier
of 10. So we calculate a need to buy 7 contracts.Under such contracts a specified number of
dollars per point of $10 is to be applied.
The cost at the time of writing is 32 cents per point, so the total cost for a 1000
point contract is $320 to which we must apply the investment multiplier of 10 =$3200. Each contract then costs
$3,200 for a total premium payable of $22,400.

However is there was to be very sharp correction
of say 30% prior ton expiry the option purchase would afford hedging as follows:

The intrinsic value of one contract would be
5350- 4127=1223 points @ multiplier of 10=$12, 230 per contract times 7
contracts =$85610

Less original cost =$22400

Hedging achieved $63210

Fall in prices $120.000

Loss absorbed in excess 10%$40,000

Less cost of cover $22,400

Intrinsic value $57,
600

Time value, the time value unexpired $5,610

Index now trading at 4127. Note that if the index rose instead of falling the put
option does not inhibit any upside. Large scale catastrophic losses (GFC) render the insurance much more worthwhile.

Final expiration of open positions.

To recap options cover varying time periods
and buyers and sellers can elect to take positions any time prior to maturity.
In the previous illustrative examples we assumed positions in late January and
examined their likely result.

In other words to examine if these positions
were likely to be in or out of the money on expiration on the 26th March 2018.

Those options that remain in the money will
be automatically exercised on the 26th March and positions finalised by
execution by brokers on behalf of their clients. If you elect to use options
you will be required to sign a derivatives agreement with your on line or full
service broker. Clients get BUY
and Sell notifications at brokerage according to broker agreements.

The market in options.

Just to recap there
are 4 participants in the options markets: buyers of calls, sellers of calls,
buyers of puts, and sellers of puts.

·Buying and selling options is very
similar to shares in that you receive or pay a premium based on what is called
a strike price under a particular share option contract, The premium is determined
by factors inclusive of the share price, strike price and the time remaining
until expiration of the contract.

·An option contract typically
represents 100 shares of the underlying shares. There are 2 types-American and European. Holders of the
latter don’t have any rights until expiration.

·The European Indexes are for
1000 points and an investor multiplier of 10 is applied.

·Options materially affect
share prices.

Glossary of terms

A "buy-write" is selling a covered call. Call Option: gives the Buyer the right, but not the obligation, to buy a
share or option index contract at an excise price within a specific time
period.

Collateral – to be lodged by sellers as security.

Contracts that sets out the agreement for Buyers and
sellers covering option parameters.

Contract sizes – 100 shares or 1000 points by 10 for
indexed options.

A covered call is an options strategy to holds a share (long
position) and sell options on that same share aimed at generating increased
income from the share held. A covered call is also called a
"buy-write". Exercise price is usually called the strike price.

In and out of money will be determinants of whether or not the
underlying share or index level reaches or exceeds exercise prices.Outside of money is indicative current prices
will render the option worthless on expiration.

Option Style: An American option is an option that can be
exercised any time prior to expiration or in other words anytime during its
life. European options are exercisable only at maturity.

Putt Option

A Put option confers a right, but not the obligation, to
have bought, at expiration, at the exercise price, the shares which are the
subject of the put option. Subject to share prices below or at the exercise
(strike) price.

Time Value of options

The time value is ex intrinsic value, a determinant
of two variables (1) time remaining until expiration and (2) the closeness of
the option exercise (strike) price to being in the money.

Investment Multiplier

Under a contract a specified number of
dollars per point when using European Index Options. Usually $10

Saturday, February 10

At our next concert of the Open Door Choir we intend to sing this number inclusive of the man made sound effects. By rubbing the hands to commence, then for different sections begin to click their fingers at varying intensities, followed by varying stomps, you can emulate perfectly a storm.

Friday, February 9

In
Australia the information in published accounts is highly regulated in
accordance with comprehensive legislative and professional bodies that issue
standards and guidance. In addition the ASX (Australian Stock Exchange) provides
rules for listed entities which come under the provisions of contact law.
Whilst the ASX also issues a number of non- binding suggestions, nevertheless they
have been almost unanimously adopted. Hence the format of Reports for most publically
listed entities is very similar.

From
my experience the Australian approach which tends to favour descriptive principles
rather than a prescriptive approach favoured by the US is far more effective. People
tend to respond more ethically if one is required to use one’s imagination. In
other words applying a broadly based principled approach as opposed to being prescriptive
which risks dissolving into a purely box ticking compliance approach.

The
principal legislative requirements are contained in the Corporations Act 2001 whose
provisions are enforced by ASIC. (Australian
Securities & Investment Commission). ASIC is involved in surveillance,
investigation and enforcement of the financial reporting requirements.

The
Act gives legal effect to auditing standards requiring auditors to adhere to the
ethical standards laid down by the Accounting Professional and Ethical
Standards Board (APESB).

Input by professional bodies.

In
turn professional accounting bodies also enforce expected professional
standards and integrity from their members.

For
instance, our largest accounting body, namely CPA Australia, last year reported 94% of members met all
professional standards and requirements or had minor non-compliance issues
which were resolved before the review was finalised; and that 6 per cent of
members reviewed showed a level on non-compliance where follow-up action was
required. All such matters were resolvedafter follow-up action. These results
were similar to the previous year.

Advocacy & research- Governance Institute of Australia.

The Institute champion’s
ethics in business and for its members who may be employed as governance
professionals or legal counsels in larger organizations. The institute provides
consultative services pertaining to governance strategies and solutions aimed
at not only ensuring a company conducts its affairs ethically, but also can evolve,
grow and succeed by adopting enhanced risk management practices.

The institute engages with
government on any proposed legislative and regulatory reform.

F

inancial Reporting Council.

The
FRC appoints members to the Accounting Standards Board in Australia, and has listed its aims to reduce the cost
of capital and ensure Australian entities can compete effectively overseas. Its
principal thrust is to maintain investor confidence and to ensure accounts are clearly
stated and easy to understand. Its annual report is presented to the Federal
Treasurer.

The
ASIC Act however limits the FRC’s ability to act directly in relation to setting
accounting standards which becomes the responsibility of the Australian
Standards Board.

Rather
the role of the FRC is to monitor Australian accounting, auditing and assurance
standards to ensure their relevance to capital markets and reporting by the private
and public sectors.

Its principal role is to oversee auditing
and assurance standards for world-wide use, whilst ensuring it continues to be best
practice in Australia. However the technical know-how in achieving that aim is
delegated to the standards Board.

Accounting Standards Board in Australia.

Hence the actual drafting of accounting standards in
Australia is governed by the Australian Accounting Standards Board.The process involves continual review and
commences with discussion papers for both internal and external consultative
reviews with the various professional bodies.

The Board has 11 members including the Chair. The Chair
is appointed by the Minister for Superannuation and CorporateLaw.
Members, are appointed by the Financial Reporting Council (FRC).

According
to its latest report accounting standards have increasingly become
internationalised to ensure consistency in their presentation. Currently the
International Financial Reporting Standards (IFRS) has been adopted in over 100
countries, including China, European Union, India, Korea and New Zealand.

About Me

I have worked in the roles as Company Secretary or Divisional financial executive with larger Australian based multinational companies before changing careers in favour of sales and marketing for the latter 12 years of business life.
My particular interests include corporate social responsibility, ethics and research into more sustainable business practices.
I am a fellow of CPA Australia and an Associate member of the Governance Institute of Australia which was previously called the Chartered Secretaries Australia. I am chairman of the Malawi Support group who are a small group of catholic parishioners who raise funds to support a sister parish in Malawi.